Accounting Standard Setting Essay Example

Accounting Standard Setting Essay Chapter 7 SHD Learning Outcomes At the At the end of this lecture, students should be able to explain: ? The three theories proposed to understand the process of regulation – public interest, regulatory capture and private-interest theory ? a comparison of the free market and regulatory approaches to standard setting ? International standard setting ? Standard setting in Malaysia Introduction †¢ Since 1960s, accounting profession has been criticized for its weakness. Failures to solve problem faced by practitioners accountant remains unresolved and lack of independence of financial information. †¢ This has led the profession to seek a legitimizing procedure for standard setting process (standard back up by regulatory bodies) †¢ Q: Should accounting standards be formulated mainly by authoritative bodies or left to the free market? †¢ Q: Why do we need government intervention in developing the standards Nature of Accounting Standards †¢ Provide practical and handy rules for the conduct of accountant’s work †¢ Standards dominate the accountant’s work Constantly changed, deleted, and/or added †¢ Generally accepted as firm rules, backed by sanctions for nonconformity (peculiarity) †¢ Generally consist of three parts: A description of the problem to be tackled A reasoned discussion (possibly exploring fundamental theory) or ways of solving problem Then, in line of decision or theory, the prescribed so lutions †¢ Some reasons to establish standards: Provide users of accounting information with information about the financial position, performance, and conduct of a firm. We will write a custom essay sample on Accounting Standard Setting specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Accounting Standard Setting specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Accounting Standard Setting specifically for you FOR ONLY $16.38 $13.9/page Hire Writer This information is assumed to be clear, consistent, reliable, and comparable Provide public accountants with guidelines and rules of action to enable them to exercise due care and independence in selling their expertise and integrity in auditing firm’s reports and in attesting the validity of these reports Provide the government with data bases on various variables that are deemed essential to the conduct of taxation, regulation of enterprises, planning, and regulation of the economy, and enhancement of economic efficiency and other social goals Generate interest in principles and theories among all those interested in the accounting disciplines. The mere promulgation of a standard generates a lot of controversy and debate both in practice and in academic circles Standard Setting Approaches – Why Accounting is Regulated? Theories of Regulation: †¢ What was the reason for government intervention in the market for accounting information? Answer: Three major categories of theories regulation: Public-interest (market failure theory): accounting standard setting is regulated because of the perception that the market is characterized by departures from the competitive ideal in ways that reduce benefits to society, so the government intervenes to nurtures the public interest Regulatory capture theory: although the standard setting process was originally to be regulated to protect the public interest, those roups affected by accounting information battled for control of the political process to increase their wealth and/or prestige. Results shown accounting profession captured the process, where they wanted the benefits of regulation for themselves Private-interest Theory: regulation of the process was sought by the producer group as a device for transferring profits to them, the favor then being returned in the form of votes and contribution to politicians †¢ The three theories provide insight into the differences in regulatory activity in different justification and the evaluation of suggestions for the reform of accounting regulation i- Public-interest (market failure theory) Justifies the mandatory requirement of accounting standards as a means of reducing the likelihood of market failures in response to public demands for the control of accounting information †¢ Regulation is supplied in response to the demand of the public for the correction of inefficient or inequitable market prices †¢ Constituted primarily for the protection and benefit of the general public †¢ Among potential market failures: Lack of competition (monopoly, oligopoly) Barriers to entry Imperfect information gaps (information asymmetry) between buyers sellers or certain market signals The public goods nature of so me products where the provision of the product to a single individual makes it equally and costless available to other individuals. Market failures occur since other individuals can receive the product free of charge, the normal pricing system in the market cannot function †¢ The theory was justified as a result of failures in the market for accounting information evidenced by significant number of corporate collapse, even after auditors had certified accounts as ‘true fair† †¢ Calls for stricter accounting standards or for changes in standard setting processes following major corporate collapse †¢ The theory present the reason for or the origin of government intervention in the accounting standard-setting processes being the rectification of failures in the market for accounting information Ii Regulatory capture theory Regulation is supplied in response to the demands of special interest groups, in order to maximize the income of their members †¢ Assumption: (1) all members of society are economically rational; each person will pursue his/her self-interest to the point where the private marginal benefit from lobbying regulators just equals the private marginal cost †¢ Regulations, therefore, have the potential to redistribute wealth †¢ People lobby for regulations that increase their wealth, or lobby to ensure that regulations are ineffective in decreasing their wealth †¢ (2) The government has no independent role to play in the regulatory process, that interest groups battle for control of the government’s coercive powers to achieve their desired wealth distribution †¢ Purpose of protecting the public interest is not achieved as the regulatee comes to control/dominate the regulator †¢ Captures occurs, if regulated entities: Control the regulation the regulatory agency Succeed in coordinating the regulatory body’s activities with their activities so that their private interest is satisfied Neutralize or ensure non-performance by the regulating body In a subtle process of interaction with the regulators, succeed in co-opting the regulators into mutually shared perspective, thus giving them regulation t hey seek †¢ Reasons for capturing – regulatory decisions have major effects on the interests of regulated industries. For example, the permission to operate a business or to provide a particular product or service may be granted or denied by regulatory agencies, and the level and structure of prices charged for the industry’s output. †¢ Non-industry groups i. e. the public + consumers find themselves in a different situation with each person’s individual stake in a regulatory decision very small, perhaps imperceptible †¢ Accounting standard setting? The board was successfully captured by the accounting profession. Accounting profession were claimed as successfully control the regulatory output of the standard as a result of various factors: The existence of a complex industry product which was under the control of accounting profession The majority of the board members having accounting backgrounds and/or future employment opportunities in the accounting industry The geographical dispersion, organization costs lack of pre-existing communication channels of non-industry groups The regulatory agency having minimal resources compared with the accounting profession iii- Private-interest theory †¢ Regulation hence standard setting, is regulated by the relative political power of various interest groups †¢ Power to coerce, as with its power to prohibit or compel and/or to provide or withdraw taxes subsidies, the government can and does selectively help or hurt many businesses †¢ There are many bidders (in the political market), but only one group will be successful, the group th at makes the highest bid †¢ Producer groups are most often the highest bidders Regulation, therefore, does not arise as a result of government’s response to public demands but is sought by the ‘producer’ private-interest group is designed operated mainly for its benefit †¢ Producer private-interest groups can supply these resources by providing campaign contributions political advertising to elected officials lucrative opportunities for post-government employment †¢ Regulation was seen as a device for transferring profits to well organized groups in the form of subsidies, price fixing, control of entry of political competitors suppression of the production of substitutes, if the group will return the favor with votes contributions to politicians †¢ Eventually, the supply of government intervention in the accounting standard-setting process was the result of its demand by corporate managers directors who wanted to protect themselves from the possibility of over-regulation following the media the shareholders backlash associated with the spate of corporate crashes Approach to Standard Setting: Accounting can be seen as an information industry ie. the business of accounting is to produce information.